6 Strategies that all Early-Stage R&D Companies Should be Thinking About
By: PJ Donohue, CPA
1. R&D Tax Credits Used to Offset Payroll Taxes:
Early-stage R&D companies are generally eligible for tax credits based on their qualified research expenses. Since early-stage companies rarely have taxable income to utilize these credits, they can instead elect to utilize them as an offset against payroll taxes. With a limit of up to $500,000 per year for up to five years, that is a potential cumulative tax savings of up to $2.5 million.
2. Know the costs eligible for the R&D tax credit:
Wages of R&D employees, R&D contractor expenses (at a discounted 65% rate), and supplies used in R&D are among the most common of the costs eligible for the credit. Notably, only domestic costs are eligible, so be sure to exclude any R&D done by employees or contactors overseas.
3. Select the most beneficial tax structure:
It is important to select the most appropriate tax structure for your business. Many early-stage companies organize as an LLC for simplicity but later look to convert to a corporation. Filing as a C-corporation provides a unique opportunity for 1202 Qualified Small Business Stock (QSBS) status, which has substantial tax benefits when you sell your shares. Furthermore, investors expect their portfolio companies to be structured as Corporations for legal purposes. It is important to understand all the legal and tax options available to determine which option is best for you.
4. 1202 Qualified Small Business Stock (QSBS):
Section 1202 encourages investment in small businesses. When investors hold QSBS for at least five years they are eligible to exclude up to $10 million of gain from their income tax return ($15 million for stock issued after July 4th, 2025). However, to ensure this huge tax advantage is secured there are specific requirements that must be met.
- QSBS stock must be acquired directly from the C-corporation, either purchased for cash or exchanged for property or services. QSBS purchased from another person loses its QSBS status. A notable exception is when received as a gift.
- To be considered a Qualified small business the corporations aggregate gross assets must not exceed $50 million ($75 million for stock issued after July 4th, 2025) at any point prior to or immediately after the issuance of the stock.
- Certain businesses are not eligible for 1202 stock exclusions, such as those in health, law, engineering, accounting, consulting, banking, farming, to name a few. However, companies engaged in startup and R&D activities that provide products or services to those companies are still eligible for 1202 stock exclusion.
5. Sales & Use tax exemptions:
Many states offer sales and use tax exemptions when purchasing equipment used in R&D activities. It is important to be aware if your state has an exemption and the rules for utilizing that exemption. For R&D startups, this exemption can be a big money saver which can make all the difference!
6. Bonus depreciation:
The One Big Beautiful Bill Act (OBBBA) restored the full and immediate deduction (often referred to as bonus depreciation) of all equipment purchased after January 19th, 2025. This provision generally covers all furniture, computers, equipment, leasehold improvements, and much more. This provision allows the tax deduction timing to match cash outflows and prevent unnecessary income tax bills for companies.
Our team of CPAs are here to assist with optimizing your tax strategy, please use the link below to schedule a call to learn more.
